Hi Roberto,
Friday, December 31, 1999, 3:35:28 AM, you wrote:
DH> >This is [was going to be] off list because though interesting,
DH> it's not a sustainable ag topic, strictly speaking.
RV> I'll reply off-list first, and post it again on SANET if the
RV> discussion takes off. A lot of farmers are heavily indebted, so I
RV> imagine such information should be interesting to them.
It looks like it has (Hugh & Bart so far - as far as I've noticed), so
that's fine with me - I just didn't want to be the one to do it at
first - but I did go ahead and post it in the end.
Thanks for clearing this up a bit more. There are bound to be country
dependent differences, also - Mexico for one has passed laws
prohibiting the Govt. from guaranteeing loans made by Banks to
corporations affiliated with any of their principle officers, for
instance; higher reserves are now required and official norms have
been set for "standard banking procedures" for securing loans, which
otherwise are not protected. There were many more restrictions made on
guaranteeing loans. (I have them here).
This was another point you didn't mention - not only do banks issue
funds on their own hook, the repayment of those funds may be
guaranteed by the governments currently in power. It can result in a
very neat game of collusion, and the US has not been immune from this.
However, Mexico is now beginning to exercise some control by limiting
the guarantee to loans made only under certain conditions.
DH> OK, Roberto, let's go over this again. You are making a claim
DH> that I can neither refute nor confirm at this time. For
DH> discussion's sake,
RV> You can also look it up in any textbook on banking/finance or any
RV> economics textbook with a chapter on the same subject. In the book
RV> index, try looking for "fractional-reserve banking".
DH> I have to assume that any credit made by a bank is backed by
DH> money that has to reside somewhere other than the banks own
DH> books. Therefore: I understand you to be saying that banks issue
DH> credits that *aren't* backed by money, just as governments can
DH> create money that isn't backed by reserves of foreign currency,
DH> gold or something
RV> That's what it amounts to. When one bank receives a deposit, and
RV> proceeds to lend 90% (or whatever fraction) of that, the bank
RV> doesn't have to back it up with anything. It is the borrower that
RV> has to back it up with some assets.
DH> (This is a dangerous thing for a government to do, btw - it's
DH> inflationary and can result in the devaluation of the country's
DH> currency, if a lack of confidence results from it, as often
DH> occurs. To get away with it even occasionally, a country would
DH> have to have a strong, productive economy in other respects. I
DH> live in Mexico where
RV> Almost all banking systems in the world do "fractional-reserve
RV> banking", including Mexico I'd presume. So they do it daily, all
RV> of the time. It is not just the government, it is the corporate
RV> banking system.
DH> Once again: You are saying that the credit system is generated by
DH> the banks themselves and that this is in accordance with the legal
DH> structure in most economically strong countries?
RV> Not most economically-strong countries, but all countries under
RV> the fractional-reserve banking system, and that's practically all
RV> countries in the world (I don't say "all" because I'm not sure
RV> about all Muslim countries).
DH> OK, the amount of money a bank can lend is related to the
DH> percentage they are required to hold in reserve. What I want to
DH> know is, *HOW* can they lend money they don't have? Where do they
DH> "get" it? Do they
RV> They simply lend up to 90% of their deposits. They don't get it
RV> from anywhere: they CREATE it. And if you look at the entire
RV> banking system, they can create a maximum of $900 from your $100
RV> deposit (assuming 10% reserve requirement). When you borrow from
RV> the bank, they simply tell you: your loan is approved, you can
RV> start issuing checks against your checking account now. They've
RV> all worked it out, and know from experience how much of the total
RV> currency (coins+printed money) is kept in the bank.
Their books are undoubtedly legally subject to scrutiny by external
auditors, under certain conditions.
RV> This is why bankers are so conservative. Anything that rocks the
RV> boat and leads people to withdraw their cash is a threat to them.
RV> If people withdraw more than 10% of their deposits, the whole
RV> thing can collapse. This is why they are so scared of the y2k
RV> problem. (Tomorrow, as y2k problems actually occur, things will
RV> start to get exciting...)
It simply never happens, statistically. But it could.
DH> themselves get credit with a central bank? If this is the case,
DH> there are undoubted criteria that the bank has to meet in order
DH> to qualify, which does not exclude the possibility of that a
DH> "bankers club" exists (but that is true in most fields, as well
DH> as on sanet). Please be as explicit as possible, including the
DH> country you're referring to in any example you give.
RV> It doesn't involve borrowing from the central bank. If you're a
RV> banker under a fractional-reserve banking system, you are part of
RV> the "club". This is true under every country that allows banks to
RV> lend part of the deposits they receive from the public
RV> (fractional-reserve banking).
DH>> Banks have to deliver some kind of documentation to whoever
DH>> receives a credit. You are saying that banks are "licensed" to
DH>> issue documents that aren't backed by anything except the
DH>> percentage of reserves then in effect. I know there is an element
DH>> of trust involved, but am not
RV> Yes. The fraction of deposits they keep as reserve is what backs
RV> up the loans they make, nothing else. (Well strictly, the
RV> borrower's collateral is the back up.) This is why banks CREATE
RV> money, in multiples of the deposit they receive from the public.
RV> I'll go through it again:
RV> First assume 10% reserve requirement. This figure is not
RV> arbitrary. It reflects a system-wide average estimate of how much
RV> currency people actually keep and how much of it they deposit in
RV> the bank. So, we'll assume in the explanation below that people
RV> tend to keep no more than 10% of their liquid assets in currency,
RV> outside the banking system.
RV> Assume you deposit $100 in bank A. $90 is targetted for lending,
RV> 10 kept for reserve. That $90 loan is eventually spent (in the
RV> form of a check payment most probably), and the check deposited in
RV> bank B. Out of the $90 deposit, another 90% or $81 can be lent
RV> out. Eventually, this $81 is deposited in another bank, out of
RV> which 90% or $72.90 can again be lent out. And so on.
OK, so it's not just one bank that is generating all the $900 loaned
out then. This happens at the "banking system" level.
I just reviewed what Hugh posted and see I was wrong:
HL> Banks actually DO do things this way. The mechanism is called the
HL> fractional reserve system. Let's say they are required to keep on
HL> hand a fractional reserve of 10% of the "money" that they issue as
HL> credit. This means that if you deposit $100 dollars of cash in the
HL> bank they can put this cash in reserve and issue credits of $1,000
HL> against it since 10% of $1,000 is $100. Actually it is never quite
HL> supposed to max out like this and it works more like they issue
HL> the credit and will put it in your account on the books. But only
HL> a small portion of the credit is out in liquid cash at any one
HL> time.
So by calculating it that way, a bank can do that by leaving the
deposit intact.
But the point is that evidently much more "money" is in "circulation"
in a given country than was actually MINTED or PRINTED by it, and I
see no reason to assume that given the existing level of international
transfers, this is not extended world wide. That is weird, but has a
cumulative kind of logic to it - in fact, it's unavoidable.
RV> Deposited For lending Kept in reserve
RV> Bank A 100 90 10
RV> Bank B 90 81 9
RV> Bank C 81 72.90 8.10
RV> Bank D 72.90 65.71 7.29
RV> ... ... ... ...
RV> ------- -------- ------- --------
RV> Banking 1,000 900 100
RV> system
RV> Simplistically, it is *as if* the banking system treated the
RV> original $100 deposit as the actual 10% required reserve, meaning
RV> that the banking system imagines itself having increased its
RV> reserves by $1000 (see total deposits), out of which it can lend a
RV> maximum of $900. What if some don't keep the money in the bank,
RV> but keep it in cash? The averages have all been worked out from
RV> experience, and system-wide, the banking system knows that as long
RV> as all banks keep 10% in reserve, these variations are all taken
RV> care of. If withdrawals from one bank exceed the average 10%, it
RV> can borrow from the Central Bank (or other banks for that matter).
RV> But they've worked out the averages, which is the reason for the
RV> reserve requirement.
RV> Maybe, I still didn't explain it well enough. As I said, any
RV> textbook on banking/finance or economics (see banking/finance
RV> chapter), might contain a clearer explanation. Look for
RV> fractional-reserve banking.
RV> Roberto
No, now I've gotten the idea - it's a system wide thing and is the way
the world economy works these days. It COULD all come crashing down,
and one bank COULD loan out $900 from your $100 deposit, if it kept it
all in reserve. It's part of the economic system and whatever money is
loaned is also coming back to itself from other banks, so it can
inflate almost indefinitely. In the end, it could very well be much
MORE than $900 - and no one will ever know, unless the system crashes
- which nobody in a position of responsibility wants.
Now I understand why Mexico's federal govt. insisted on "saving the
banking system", while the opposition claims that it's the bankers
themselves that are being saved. The system itself is a house of cards
supported by practices whose validity is founded as much on peoples
motives and the existing depth of understanding regarding "standard
procedures", along with the legal basis of same.
There is also a saying here: "Rio revolcado, ganancia de pescadores" -
A roiling river is to the fisherman's benefit. The opposition wants
the system to crash and thus inherit power by virtue of default - by
discrediting those already there.
Since this danger is inherent, it's indispensable that banks make
loans in a responsible manner and that this be defined by law, in
terms of any guarantees being forthcoming buy the countries central
banking system (often linked to the government and the value of the
itself).
The alternative is worse - no credit is available. It's like
democracy, or capitalism; which have to exist within a defined set of
rules in order to work in a given society. There are no complete
freedoms - people can't fly like birds and dope can't be sold legally
in schools etc. The "best" possible options are obviously a long way
from being defined, however. And yet, a lot of ground HAS already been
covered.
Thanks to both you and Hugh for the clarifying this. Have a happy new
year (and be ready for the next one).
Douglas
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